Between 2000 and 2014 the gold price has risen from US$300 per troy ounce to over US$1,300. However, this run-up in prices has been driven mostly by demand from retail investors, especially from China and India. So far, institutional investors — especially pension funds — haven’t been very eager to jump on the bandwagon. Pension funds invest less than 1% of their assets in gold o
Between 2000 and 2014 the gold price has risen from US$300 per troy ounce to over US$1,300. However, this run-up in prices has been driven mostly by demand from retail investors, especially from China and India. So far, institutional investors — especially pension funds — haven’t been very eager to jump on the bandwagon. Pension funds invest less than 1% of their assets in gold or gold-related investments. Yet these institutional investors represent over US$50 trillion, capable of propelling a market to absurd highs. So when will pension funds buy gold and push up its price?
According to the Asset Allocation Survey by the US Council of Institutional Investors, pension funds invest a mere 1.8% in the broad commodities category, which equals US$900 billion. But then we’re talking commodities, not precious metals.
If the S&P / Goldman Sachs Commodity Index is any indicator of how much is actually invested in precious metals (i.e., gold and silver), than only a mere US$16 billion (1,81% of $US900 billion) is invested by pension funds in gold and silver. In other words, 0,032% of all pension assets are invested in precious metals.
Even when we assume that half of all commodity investments by institutional investors are invested into gold and silver, only a 0.9% of all pension assets would be invested in precious metals. (It is important to note that pension funds in the US were banned from trading commodity futures until the beginning of the 1990s.) Thus, how much gold do pension funds have? Practically nothing.
Permanent gold bears never explained how gold could have been a “bubble”, even though a great majority of institutional investors remained on the sidelines.
To answer the question whether pension funds will buy gold, we will turn to another important question: are pension funds susceptible to bubble investing?
The unequivocal answer is: yes, they are. Pension funds held massive positions in stock markets during the dotcom bubble and before the recession of ’07 and were net sellers of equities during both crashes. Likewise, European pension funds lent billions of euros to Greece and other fiscally reckless Euro-countries, while trying to sell their bonds at the worst possible moment. Pension funds exacerbate herd investing; not soften it.
So, pension funds are susceptible to bubble investing. They get caught up — just like retail investors — in market psychology, investing in the wrong assets at the wrong time. But why is it that pension funds seem to mimic each other? Aren’t they supposed to be the professionals and avoid the pitfalls common to ordinary investors?
The answer is straightforward: whenever a pension fund manager invests different than his or her peers, he or she is taking disproportionate career-risk. As Seth Klarman sums it up: “Acting with the crowd ensures an acceptable mediocrity; acting independently runs the risk of unacceptable underperformance.” It’s better to be as average as possible. It’s better to lose with the rest, than to lose alone.
Our observations are backed by a study that herding behavior among pension fund managers are consistent “with incentives for managers to be close to industry benchmarks” (Raddatz & Schmukler, 2013). In addition, it should be no surprise that with the emergence of pension fund powerhouses the average holding period for stocks has come down dramatically (from 10 years in 1940 to less than a year today).
Our conviction is that they will; pension funds will eventually buy gold and gold-related investments. We are currently in the midst of a series of bubbles in both bonds and stocks of most advanced economies, and real estate has been a terrible business in a number of countries for various years now. Eventually pension funds will — due to their mimicking nature — play catch up and invest part in precious metals, disappointed by the returns in stocks, bonds and closely related alternative investments. And even a small increase of pension assets in precious metals, would send gold prices much higher.
Gold investors should therefore await the pension fund avalanche for higher gold prices with great anticipation, as a child eagerly awaits the swift descent in a roller coaster ride while climbing slowly to the top. It should be clear by now that investors need to be on the roller coaster before the cars leave the station, not when the roller coaster is already running its course. From 2001 to 2011 we already made a ride and we’re currently back at the station: so hop in to profit from the great pension fund avalanche that is coming.
A Dutch pension fund invested about 7% of its assets in physical gold and was directly overruled by the central bank of the Netherlands stating that “gold is too speculative” and a maximum of 3% of total assets was to be applied to commodity investing, let alone gold. The fund managers disagreed and successfully brought the case before the court: they won their case and are now allowed to invest more or less freely in precious metals. More gold investment seems, therefore, a question of time, not alone in the Netherlands, but all over the world as pension funds seek returns elsewhere.
What will the catalyst be for the great move into gold by pension funds? When will the cars of the final gold roller coaster start moving? Frankly, it could be anything. It could be fiscal problems in Europe, Japan or the US, a renewed recession, an unravelling of the pending stock market crash or building geo-political tensions. To think that we can predict the catalyst would be a pretence of knowledge. But we are certain that right now we have favorable conditions for a new run-up in gold prices.